Money is something that each and every one of us have to deal with on a daily basis. Regardless whether you are a single person renting or a family of four with a mortgage, you need to know the basic financial terms that often pop up on tv, in the media or on your bank statement in order to know what you’re getting yourself into, and how to make the best choices for you, financially.
Dianne Charman is a certified AMP Financial Adviser and she has taken the time to decode the jargon most commonly used in financial terms.
1. Credit rating
“Credit rating is a term that gets thrown around a lot and while people might know what it means on face value, they might not fully understand it in depth. Your credit rating is all the information on your credit report summed up into one number.”
“The higher the score the more “creditworthy” you’ll be to lenders, whereas a lower credit score can make it more difficult to borrow money. But why is your credit rating important? It influences the amount of credit you can borrow, as well as interest rates and other specific terms a lender might offer.”
“Banks will use your credit rating in conjunction with other factors to decide whether lending you money is a risky move. Getting a grasp on your credit rating is important, especially if you are house hunting and looking to borrow.”
“The number one factor that affects your credit rating is paying your bills on time, whether it is your phone, credit card or loan repayments.”
2. Gearing
“In finance terms, gearing simply means borrowing money to invest. If you borrow money to invest, this greatly increases your credit risk. As with any risk, it could pay off as gearing could help you build wealth faster. There are three types of gearing.”
- Negative – Negative gearing is when the interest payments and costs you incur are higher than the income you receive from the investment. Put simply, you run at a loss.
- Neutral – Neutral gearing is when interest payments and other costs are equal to the income you receive from the investment.
- Positive – Positive gearing is when the interest payments and other costs are lower than the income you receive from the investment.
“Gearing can be an effective way to make the most of your investments. How and whether you use gearing will depend on your circumstances. As gearing can amplify your gains it can also amplify your losses, so it may be worth consulting a financial adviser before jumping into anything.”
3. Equity
“Another common finance term that we often hear but might not understand the true meaning of is equity. In short, equity refers to the current market value of your home minus the amount still owing on your home loan. Equity can be a valuable resource to help you purchase an investment property by securing further finance.”
“To calculate how much equity you have you’ll need to undertake a property valuation. However, as a basic rule of thumb if your home is worth $800,000 and you still owe $300,000 you have $500,000 in equity. It is important to remember that as the value of your home increases or decreases with the housing market, the equity value will rise or fall.”
“You don’t need to sell your property to access the equity. You can do this by borrowing against the equity and taking on another loan, or by increasing your existing loan. There are a number of factors to consider with borrowing against the equity on your home, so it is important to speak to your lender and financial adviser.”
4. Self-managed Super Fund (SMSF)
“A self-managed super fund is a super fund where you’re in control. You’re not only a member, but also the trustee, allowing you to be in charge of the investment strategy and manage your investments. The beauty of SMSFs is that they are flexible and allow you to invest in different assets such as property, private companies and international assets.”
“SMSFs have a few advantages over retail and industry super funds, one such example is allowing for multiple members. SMSFs allow up to four members, meaning you can add your partner or family members, pooling your funds together to grow your balance and increase your investment options, which may be more cost effective.”
“The ins and outs of SMSFs can be very complex and the setup requires a few things to be put in place to ensure it complies with superannuation laws.”
5. Guarantor
“Guarantor is a common term in the finance sector, meaning someone who guarantees another person’s loan or credit. In other words, a guarantor will pay the loan in the event the borrower themselves cannot. It might seem easy enough to agree to go guarantor for a loved one, however it is a major financial commitment that shouldn’t be taken lightly.”
“There is a lot to consider when going guarantor for someone as it is a high risk scenario. Understanding the inner workings of a guarantor is important, especially for baby boomers who have kids that might be thinking about entering the property market.”
“Consult your financial adviser first to discuss what options are available and if becoming a guarantor is something you can do in your current position and always have a plan for the borrower you are guaranteeing to take over the loan eventually.”
“When looking at financial terms and jargon it’s always a good idea to review the meaning and what the potential impacts can be, making an informed decision means you’ve worked through all worst-case scenarios and have a plan for any eventuality.”
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